Uruguay: Selected Issues

Abstract

Uruguay: Selected Issues

Uruguay: Boosting Growth Through Diversification1

A. Background

1. Uruguay has achieved high growth rates and made significant progress in its integration in the global economy over the past decade. The country has achieved an average growth of 4.8 percent between 2003–2015 on the back of good macroeconomic management and favorable external environment. Income per capita has almost doubled in real terms during the period, becoming among the highest in the region.2 Poverty and unemployment have declined drastically.

2. As a small open economy largely based on exports and tourism, Uruguay is exposed to volatility of commodity prices and the broader external economic environment. Two important features of Uruguay’s economy stand out: strong linkages with neighboring economies and relatively high growth volatility. Uruguay’s economy has been closely linked to Brazil’s and Argentina’s economies over the past three decades (chart). Like other countries in the region, Uruguay has also experienced high growth volatility due to commodity cycles and regional linkages.3

A03ufig1

Real GDP

(Index 1980=100)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Staff calculation
A03ufig2

Growth Volatility (2000-2014)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Staff calculation

3. Against this background, Uruguay has recognized the need to diversify its sources of growth. The diversification is even more important when global commodity markets appear to be in a secular downturn in the coming years amid subdued outlook of its neighbors and the region. Going forward, given the limited scope for achieving significant economies of scale, Uruguay has to rely on the export of goods and services with higher levels of value-added to a diversified export market for further growth.

4. This chapter reviews Uruguay’s progress on diversification and the challenges it needs to address to achieve a higher and more stable growth. It first examines Uruguay’s trade pattern, diversification of value content of its product so far, and the growth linkage between Uruguay and its neighbors. The paper then discusses policy options to promote further diversification.

B. Diversification and Growth: What to Diversify?

5. Diversification is important for economic growth and stability. Diversification has several dimensions: export diversification, output diversification, and quality upgrading (chart). A related strand of the literature looks at economic complexity—exports of goods intensive in skill and technology (See, for example, Hidalgo and Hausman 2009, Rodrigues and Ke 2014). Cross-country experience suggests that diversification into new products and trading partners as well as increases in the quality of existing products has been conducive to faster economic growths (IMF 2014, Henn et al. 2013). Similarly, limited economic diversification has also been linked to longstanding difficulties in achieving resilient growth (Mejia 2011).

6. Diversification is also associated with lower output volatility and greater macroeconomic stability. A more balanced product mix of export basket can help stabilize export earnings, reduce output volatility, and enhance a country’s resilience to external shocks, thereby mitigating vulnerabilities caused by globalization and trade openness (Koren and Tenreyo 2007, and Haddad et al. 2013). Diversification across partners also helps reduce volatility of GDP per capita (Jansen et al. 2009; Frashbaf, 2012).

7. As a small open economy without significant economies of scale, Uruguay could gain more from quality upgrading (higher value-added) and export market diversification than from further sectoral diversification. Given its size, the country cannot opt to diversity its economy to the same extent as larger countries such as China, Korea, or Brazil. Rather, the diversification should be grounded in its comparative advantages, harnessing knowledge spillover to increase competitiveness in higher levels of productivity and value addition.

C. Uruguay’s Progress in Diversification4

Export diversification across partners and products

8. Uruguay has made progress in diversifying its export markets. According to trade statistics, Uruguay is exporting to around 150 countries around the world.5 Between 2004 and 2015, export to China increased from 3.5 percent to 13.3 percent respectively. At the same time, export to “other countries” excluding China, EU, and its neighbors increased from 31.7 percent of total export to 42.7 percent. The weight of exports to the European Union and North America has decreased as a percentage of total exports. Exports to Brazil have remained significant, staying around 20 percent.

A03ufig4

Export Destination

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Central Bank of Uruguay

9. Uruguay has also made progress in diversifying its export products. Based on the Product Concentration Index, Uruguay is more diversified than many other countries in the region (chart).6 Exports of commodities have increased significantly, both in values and as a share of total exports, over the past decade, driven by export of animal products (mainly beef) and vegetable products (largely soy beans). Export of Wood (pulp) also increased (chart).

A03ufig5

Herfindahl-Hirschman Product Concentration Index 1/

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: World Integrated Trade Solution (WTIS).1/ Measures dispersion of trade value across export products. More trade value concentration in exports has index closer to 1.
A03ufig6

Share of Exports

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: World Integrated Trade Solution

10. Tourism, a major sector in Uruguay, remains largely dependent on its neighbors. Argentina has been the main source of tourism revenue, accounting for about 55 percent of tourism receipts. Brazil, Paraguay, and Chile combined are the second largest source of tourist inflows, contributing around 22 percent of tourism receipts.

A03ufig7

Tourism Receipt

(Share by country, percentage)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Central Bank of Uruguay

Quality upgrading of export products

11. Increasing commodity exports have been accompanied by increased quality in food and animal products. Based on the IMF Product Quality Upgrading Index, the quality of food and live animals has improved close to the level of quality of New Zealand and Australia—its key competitors in international markets (chart).7

12. However, there is scope to upgrade further the quality of Uruguay’ existing export basket. Uruguay’s position on sectoral quality ladder points to the further potential for quality upgrading within existing products baskets, especially in Uruguay’s main export- food and animal products (chart).8

A03ufig8

Quality Index: Food and Live Animals

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: IMF Quality Upgrade Index
A03ufig9

Share of Export and Quality

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: IMF Quality Upgrade Index

Economic complexity

13. Uruguay has also increased its economy complexity as reflected in the Economic complexity index (chart). The index reflects not only the breadth of a country’s exports, but also how knowledge intensive they are.9 Uruguay stands out as being more complex than many countries in the region (chart). However, Uruguay’s position on the global ranking of economic complexity index suggests that there is still untapped potential for further economic progress (chart).

A03ufig10

Economic Complexity Index

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Atlas of Economic Complexity
A03ufig11

Economic Complexity Index, 2013

(Cross-Country Comparision)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Atlas of Economic Complexity

D. Regional Growth Linkage: Has Uruguay Decoupled?

14. While the growth linkages with Argentina has been diminishing in recent years, it remains an important source of tourism and FDI.

  • Estimates based on rolling regressions show a diminishing sensitivity of Uruguay’s growth to growth in Argentina (chart). This could be explained by the Brazil’s increasing share in tourism and investment and the fact that emerging market economies outside Latin America, such as China, are becoming a more important source of demand for Uruguay’s exports. Nevertheless, historical evidence suggests that one percentage point growth reduction in Argentina could still reduce Uruguay’s growth by almost 0.4 percentage point.

  • Brazil and China are found to have increasing effect on the variation in Uruguay’ growth. A VAR analysis based on data for 1980 through 2014 suggests that in this period Argentina’s growth explained about 50 percent of the variation in Uruguay’s GDP Growth (chart). 10

A03ufig12

Growth Linkage with Argentina

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: staff calculation
A03ufig13

Growth Variance Decomposition

(5 year horizon)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: staff calculation

E. Enhancing Diversification

15. Key reforms could support further diversification in export markets and higher value-added content. The literature suggests reforms for improving infrastructure and trade networks, investing in human capital, and reducing barriers to entry for new products (See, for example, Daude, Nagengast, and Perea 2014).

16. A cross country comparison of the investment climate suggests several relevant areas, where Uruguay has lagged. These include improving secondary education, enhancing labor market efficiency, and upgrading infrastructure to meet rising demand of its growing economy (chart). In this context, the commitment of the government to boost infrastructure investments, revamp secondary education and skill formation for the youth, and foster an innovation-friendly business environment should be noted.

17. Existing solid institutional foundations should provide a key opportunity to implement reforms for further diversification. These include political stability, institutional quality, and low corruption perception.

A03ufig14

Uruguay Structural Challenges

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Competitive Report, World Economic Forum
A03ufig15

Institutional Indicators

(Percentile rank, 0-100)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: World Bank, Governance Indicators.

Infrastructure

18. There is scope for upgrading transport and logistic infrastructure to help enhance diversification and trade activities. Strong economic growth in the last decade has placed greater stress on transport infrastructure. Quality of port and road infrastructure has not kept up with the rising demand. While the quality of ports, electricity supply are generally good, Uruguay ranks below its peers in terms of road and railroad infrastructure (chart).

A03ufig16

Quality of Infrastructure

(1-7 best)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Competitive Reports, World Economic Forum
A03ufig17

Quality of Infrastructure

(1-7)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Competitive Reports, World Economic Forum

19. Uruguay’s logistic performance also offers scope for substantial improvement. Uruguay’s logistic performance lags behind its peers in the region, in particular, regarding the efficiency of customs and border management clearance, the ease of arranging competitively priced shipments, the competence and quality of logistics services, the ability to track and trace consignments, and timeliness to match its competitors.11 Improvements would help to create a seamless connection between farms, firms, and markets, and to attract foreign direct investment.

A03ufig18

Logistic Perfmance

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

source: Logistic Perfomrance, World Bank

Education and skills

20. Improving education and upgrading skills will help diversification and innovations to enhance the value added content. Skilled work force his crucial for moving up the value chain and for capturing knowledge spillovers from foreign direct investment (IMF 2014; Daude, Nagengast, and Perea 2014). A better-educated workforce is also more likely to spawn successful entrepreneurs seeking to branch out into improving existing products, and to absorb and adopt new technologies.

21. Declined quality of secondary education is a major constrain to Uruguay’s productivity growth and diversification effort, particularly in the context of an aging population. While Uruguay has strong performance in the provision of basic education and literacy skills, achievements at more advanced levels of education are weaker than peers at similar income level (chart). Dropout rates in secondary schools are high (chart). It will be key to improve the coverage and quality of secondary school as well as vocational training.

A03ufig19

Quality of Education

(1-7)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Competitive Reports, World Economic Forum
A03ufig20

School Attendance

(percentage)

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Competitive Reports, World Economic Forum

Labor markets

22. Labor market efficiency could be enhanced as it has decreased over the past decade (chart).12 The World Economic Forum Survey ranks labor market efficiency as the weakest aspect of doing business in Uruguay. Key elements such as cooperation in labor-employer relation, link between pay and productivity, and wage determination flexibility have lagged behind other countries of similar income level (chart). Hence, it would be useful to evaluate labor market regulations and the wage determination mechanism introduced in recent years and ensure that they strike a good balance between efficiency and appropriate protection for workers.

A03ufig21

Labor market efficiency

Citation: IMF Staff Country Reports 2016, 063; 10.5089/9781498384223.002.A003

Source: Staff Calculation; Competitive Reports, World Economic Forum
A03ufig22
Source: Competitive Reports, World Economic Forum

F. Conclusion

23. Structural reforms can help Uruguay achieve another phase of growth in the context of a less favorable external environment. Uruguay has achieved a decade of high growth, diversified its export markets, and has started upgrading the quality of its products and services. Further diversification in these two areas would help boost Uruguay’s growth. Greater diversification of markets would also help reduce exposure to adverse external shocks, and thus lower growth volatility. To enhance the diversification, an upgrade of Uruguay’s transport and logistics infrastructure, improvements in the quality and enrollment of secondary education, expansion of vocational training programs, and increase in labor market efficiency to better tie wages to productivity are key.

References

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1

Prepared by Dyna Heng.

2

Income per capita has tripled in nominal terms during the period.

3

For macroeconomic volatility in Latin America, see, for instance, Singh (2006) and Gruss Bertrand (2014).

4

Uruguay has also made progress in diversifying its sources of foreign direct investment. This chapter focuses on products and market diversification.

5

World Integrated Trade Solution (WTIS). http://wits.worldbank.org

6

The Index is a measure of the dispersion of trade value across an exporter’s products. A county with a preponderance of trade value concentrated in a very few products will have an index value close to 1. Thus, it is an indicator of the exporter’s vulnerability to trade shocks. See Reis and Farole (2012).

7

The index is calculated as the unit value adjusted for differences in production costs. IMF (2014) explains how quality is measured. The dataset is are available at www.imf.org/external/np/res/dfidimf/diversification.htm.

8

Quality ladders reflect the extent of heterogeneity in quality across different varieties of a given product. The length of a quality ladder indicates the potential for quality upgrading for each products (IMF 2014).

9

The Economic Complexity Index is based on two key dimensions: diversity and ubiquity. See Hidalgo and Hausmann (2009) and Hausmann and others (2014) for details on definition and measurement. The Economic Complexity Index is available at http://atlas.media.mit.edu/en/rankings/country/.

10

VAR includes two lags of GDP growth (in log value) of China, Brazil, Argentina, and Uruguay.

11

See the Logistic Performance Index. http://lpi.worldbank.org/

12

The indicator is calculated as 1- (Uruguay’s ranking/total number of countries). A high ranking value in the WEF survey sample countries means less competitiveness.

Uruguay: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.